Chop negative gearing and there’s savings for buyers and the budget

Negative gearing is costing the government billions but is doing absolutely nothing to boost supply. Let’s get rid of it, writes economist and MacroBusiness commentator Leith van Onselen.

As we approach the federal budget witching hour, reports have emerged over the past week that the government is seriously considering reforming Australia’s negative gearing rules, by grandfathering arrangements for existing investors and potentially only allowing negative gearing on newly constructed dwellings.

Reforms of this nature would be a wonderful development, not just for housing affordability, but also the budget.

According to the Grattan Institute, quarantining negative gearing losses would save the budget around $4 billion per year initially, falling to a saving of around $2 billion per year over the longer term. It would also remove some speculative demand from the housing market, taking the pressure off prices, improving housing affordability and increasing the rate of home ownership.

The Housing Industry Association’s claim that the removal of negative gearing would reduce the supply of rental affordability is also complete bunkum. Reserve Bank of Australia data clearly shows that the overwhelming majority of investors — almost 95% — buy pre-existing dwellings, not newly built dwellings, and that the proportion of investors buying new dwellings has fallen spectacularly since negative gearing was re-introduced in September 1987 …

Moreover, the amount of investor funds going into new housing has barely shifted in 25 years, whereas investment in pre-existing dwellings has skyrocketed …

And since investors primarily purchase pre-existing dwellings, negative gearing in its current form simply substitutes homes for sale into homes for let. As such, negative gearing has done little to boost the overall supply of housing or improve rental supply or rental affordability.

In the event that negative gearing were once again quarantined and a proportion of investment properties were sold, who does the HIA think they would sell to? That’s right, renters. In turn, those renters would be turned into owner-occupiers, reducing the demand for rental properties and leaving the rental supply-demand balance unchanged.

Nor would rents rise due to the policy change. The below chart plots the Australian Bureau of Statistics rental series from 1972, with the period where negative gearing losses were last quarantined (i.e. between June 1985 and September 1987) shown in red. As you can see, there was nothing spectacular about this period, with much higher rental growth recorded in earlier periods when negative gearing was in place …

Similarly, if we deflate the above series by CPI, in order to remove the effects of inflation, we again see that rental growth over the period when negative gearing was last quarantined was nothing special, with periods of higher rental growth recorded both prior to and subsequently …

In short, negative gearing is costing the government billions in lost tax revenue, but is doing absolutely nothing to boost supply. It also creates additional demand from tax subsidised investors, placing upward pressure on home prices and locking out would-be first-time buyers. There is little policy rationale in favour of keeping negative gearing in its current form, whose foregone funds could instead be used to fund schools, hospitals, housing-related infrastructure, or any number of other worthwhile endeavours.

The government would do well to ignore the screams from vested interests, like the HIA, which seems only concerned about protecting the value of its member’s land banks, rather than actually boosting supply.

Seriously, now why would anyone in their right mind without NG invest hundreds of thousands of their dollars in an asset which becomes the sole preserve of someone else for months at a time and in that time that vulnerable indeed perishable asset becomes worn and very often deliberately damaged? Let’s see what happens - investors will rightly withdraw, and tenants will be the ones suffering. Housing is a different kettle of fish to other investments and NG is simply a govt housing subsidy. Either way the govt goes, they will have to subsidize housing. So keep the status quo.

Hazel studiously avoids mentioning the possibility of allowing negative gearing for new homes only. So does the HIA. Defenders of the status quo cannot afford to mention this proposal, because it calls their bluff by making negative gearing do what they say it does.

I think you missed the main point of the article NG investors dont add to supply, they just add to demand. Investors would presumably still be eligible for depreciation allowances on their investment to handle wear and tear.

Negative gearing is not a subsidy or a rort at all. If you lose money on an investment you should be able to deduct it from you taxable income. Because this represents how much money you made that year. And we tax according to our means, not according to some stereotype of the evil landlord. What IS strange is that you cannot do it with other investments, like shares.

We don’t pay tax according to our means or according to some stereotype of the evil landlord. We pay tax according to the stereotype of the evil undeserving WORKER: the cost of commuting to work reduces your means and is a cost of earning your wage, but is NOT deductible against your wage for tax purposes; but a current loss on a rental property IS deductible against your wage although it is NOT a cost of earning your wage.

Another influential stereotype is that of the evil undeserving business operator: if you want to deduct a business loss against the wages of your day job, you will need to jump through far more hoops than if you want to deduct a loss on a rental property.

This blatant discrimination in favour of property investors against workers and business operators looks like a rort to me.

And by the way, you CAN claim negative gearing on shares. But we don’t hear so much about that, because shares, unlike housing, are not a necessity of life, and because the acquisition of shares is less likely to be debt-funded than the acquisition of real estate.

NG is not a “benefit” of investment property ownership. It is an acknowledgement that this investment class, like others, involves various costs like loan costs, repair costs, maintenance and management costs, etc. Being able to reduce the total amount of your income against the amount your income generating assets have cost you in losses is not just common sense, it is entirely reasonable. Stereotypes are fascinating to consider and dismiss, but so are generalisations about the rationality or otherwise of the market and its participants. In short, property is a very, very different asset and investment class to shares, and the comparison that is frequently made is fundamentally flawed. Emotion, anger, frustration, all come into play. So unfortunately, does stupidity and ignorance. This article by Van Onselen is typically imbalanced and again, does not provide any clarity for the readers around the reasoning for retention of NG, either historically or currently. All it does is feed into the same alarmist fear-mongering that all such articles do. You know the ones, about the “affordability crisis” and greedy property investors keeping young people from being able to buy amazing houses in phenomenal areas at 1960s prices. Gavin, your discussion of “wages” is lacking, and it is inconsistent with how a business owner’s business income is considered. Comparing the cost of maintaining a property investment with the cost of a worker catching the train to work is so frighteningly silly that it makes me laugh. The more accurate comparison is of course to a worker who spends money on a computer that they use for income generation purposes. Of course, that cost IS claimable against their income, unlike train fare. A business claiming a business cost/loss is an acceptable course of action, and it is comparably actually very easy. Why then should a loss made on a property “business” not be validly claimable by a property investor? It is very simple but people hear the words “negative gearing” and treat it as if it is some entirely unique consideration that property investors enjoy that no other income earner enjoys, which of course is rubbish. In addition, when looking at the actual figures (not the ones in this article) it is also clearly apparent that the actual quantum of NG benefits enjoyed by each investor is negligible as a function of the overall debt level of each investor. If anything, NG is a short term sweetener or a pressure release (like claimable, deductible business expenses are for business owners) and it is not, of itself, the sole reason for investors to invest. If it is, investors are certainly “doing it wrong”. If it is a long term part of an investor’s strategy, they are also “doing it wrong”. This ridiculous article from van Onselen implies that removal of NG “benefits” will stop all investors getting involved in property entirely, which is absolute rubbish. Some dumber or less experienced investors may see it as less attractive, but they will just be replaced by others with different financial situations or different risk appetites. And in any event, would it be a fairer and more equitable tax system? No, of course not. Would it appease the stupid and gullible? Probably.

The graphs aren’t really reflective of what is going on here. At the end of the day, there is always more existing housing stock than there are new housing so the investment is always going to be higher in the secondary market.

As for the negative gearing question, well there will be changes (hence all these stories coming out). What they will be is hard to say. I would think that they might cap the amount of deduction claimed (or change some of the depreciation rules to minimise the ability to use depreciation expense for 40 years, as is currently the case now). Interest deduction is a tricky one as the same rules apply for shares as well (which I’m sure the government doesn’t want to touch)

But for mine, the biggest rort is the one which sees people move into their investment property when they buy, and then rent it out later. By doing this, the investor gets potentially 6 years of happy negative gearing and no Capital gains action when the sale eventually occurs (it is no surprise that most investment properties are only kept for less than 5 years).
So when the sale happens,it becomes effectively tax free (even after reducing the cost base by claiming depreciation and capital works etc).

Get rid of that loophole, by saying that you have to reduce the cost base for any rentals at all on the property, and you might remove a lot of the angst here.

Great article.
Would love to see them scrap NG, or at the very least allow it only for new homes. Negative gearing was brought back by Keating in the 80’s because of a few landlords in Sydney telling fairy tales about lack of rentals (similar to HAZEL in this thread). Yet we know now, that is a farsical ruse to line their own pockets and they should be ashamed. We currently have extremely low rental availability and affordability is also at it’s lowest, both to buy and rent. And what about all the other countries in the world without NG (99% of the world), do they have a rental availability crisis? Stop the lies! I don’t think it would be a bad thing either if prices cooled off to allow more would-be tenants to build or buy rather than being stuck in the rent trap for all their lives. And what about the newer generations who missed the boat and will miss the boat? Salaries certainly don’t keep up 10% rises in property prices we’ve seen each year lately. Cutting th FHOG didn’t help either, prices continued on their merry way. Why should the FHB’s have to compete with mr/mrs investor on auction day who is simply their to take their opportunity away as he knows, he is living off government welfare to help with the repayments? And what about the graphs? If you don’t like the graph above graph it’s simple: just go and look at bank loans for property investors vs first home buyers. Is this denial stage, or just plain deliberate ignorance? No wonder the country is going broke, too many pigs with their snouts in the gov troughs, lazy speculators I call them. Gambling with the future generations livlihoods, should be ashamed.

You write: “In short, property is a very, very different asset and investment class to shares…”

So why can you claim negative gearing on both?

“…the comparison that is frequently made is fundamentally flawed.”

That “flawed” comparison is made by the current negative gearing rules.

“You know the ones, about the ‘affordability crisis’ and greedy property investors keeping young people from being able to buy amazing houses in phenomenal areas at 1960s prices.”

Ah, yes, the old straw-man technique: first exaggerate your opponents’ claims. In fact your opponents claim that FHBs would be in less trouble if they didn’t have to compete with negative gearers (at least for the existing stock of homes), and that renters would be in less trouble if negative gearers needed to build something.

“Comparing the cost of maintaining a property investment with the cost of a worker catching the train to work is so frighteningly silly that it makes me laugh.”

It is indeed frighteningly silly, because the worker’s claim is obviously more legitimate. If losses were strictly quarantined, a worker would be able to claim commuting expenses immediately while a negatively geared property investor would have to carry the losses forward. But under current rules the property investor can immediately claim losses against other income while the worker cannot claim commuting expenses at all!

“The more accurate comparison is of course to a worker who spends money on a computer that they use for income generation purposes. Of course, that cost IS claimable against their income, unlike train fare.”

The train fare should be claimable with fewer questions asked, because it is more clearly work-related. Meanwhile negative-gearing losses are not at all related to the earning of the income against which they are claimed.

“A business claiming a business cost/loss is an acceptable course of action, and it is comparably actually very easy.”

Not as easy as claiming negative gearing on an investment property. The ATO website spells out the rules on non-commercial losses. Notice that rental properties are excluded (and that business premises also get special treatment).

“Why then should a loss made on a property “business” not be validly claimable by a property investor?”

Often because it would run afoul of the non-commercial loss rules if investment properties were not arbitrarily excluded.

“…people hear the words “negative gearing” and treat it as if it is some entirely unique consideration that property investors enjoy that no other income earner enjoys…”

Which it is, as the above comparisons show. Even shares are treated less generously in that, de facto, the acquisition of shares is less likely to be financed by debt (partly because any such debt is likely to be subject to margin calls).

“…the actual quantum of NG benefits enjoyed by each investor is negligible as a function of the overall debt level of each investor.”

Being able to claim interest expenses at your marginal tax rate is not a negligible advantage over a prospective owner-occupant who cannot do the same, even if the comparison is limited to that part of the interest which exceeds the rental value.

“If anything, NG is a short term sweetener or a pressure release (like claimable, deductible business expenses are for business owners)…”

No, the non-commercial loss rules are especially hard on new businesses, which by definition have not “produced a profit in three of the past five years”, and which may not yet have earned income of $20k or acquired assets worth $100k.

“…it is not, of itself, the sole reason for investors to invest.”

Indeed it isn’t. The other reason is that unearned capital gains are taxed less than hard-earned income. To claim the discount on capital gains, you don’t even have to pretend that the property is available for rent — let alone build anything.

Negative gearing is only useful to investors if there is a capital gain along the way.
Getting rid of it would have to be carefully implemented. The problem is if the investors start losing more money than they can afford, they sell their property. If too many investors put their properties on the market at the same time, then prices will crash.

While lower prices would be good for first home buyers, the big problem for owner occupiers and investors alike, is when the banks call in loans that fall below the loan to valuation ratio and are forced to pay more to the bank or potentially lose the home. This is what happened in Spain, Ireland and many other countries where many homeowners owed the banks much more than their homes were worth.